The investor-state dispute settlement (ISDS) system is one of the most elaborate, yet also most heavily criticized mechanisms in the field of international investment law. It enables a foreign investor to initiate proceedings directly against the host State without first exhausting all legal remedies available in the host country. The legal foundations of the system rest on bilateral and multilateral investment protection treaties, as well as individual investment contracts.
The historical development of ISDS is closely connected to the decolonization processes of the second half of the 20th century. Prior to the Second World War, foreign investors mainly relied on the courts of the host country and on diplomatic protection offered by their home country. Diplomatic protection was, however, a complicated and overly politicized instrument that often caused tensions between States, creating a demand for an effective international mechanism to settle investment disputes. An important milestone in this regard was the German-Pakistani Investment Protection Agreement, signed in 1959, which is considered the first modern bilateral investment treaty (BIT).
The main feature of the ISDS procedure is its structural asymmetry: traditionally, proceedings can be initiated solely by the foreign investor, who acts as the claimant, while the host State assumes the position of respondent, and may be limited to filing a counterclaim. Cases are typically adjudicated by a three-member arbitral tribunal set up specifically for the dispute. The decision is final, and there is no general appellate body for reviewing the merits of the case. In the event of a breach of an investment protection obligation, the principal legal consequence is typically an award of monetary compensation.
Supporters of ISDS point out that it depoliticizes investment disputes and reduces concerns about potential bias in domestic courts (“home-field advantage”), thereby promoting foreign direct investment. However, as the number of ISDS cases has risen, the system has come under growing criticism. The main objections concern its structural asymmetry, its possible impact on State sovereignty and the perception that it grants foreign investors unjustified additional rights over domestic companies.
The concept of “regulatory chill” is one of the main points of criticism of ISDS. This phenomenon refers to cases in which a host State, fearing potentially substantial damages awards, may refrain from exercising its regulatory powers, or may delay taking action to implement measures in the public interest, for example in the areas of environmental or public health. The risk of “regulatory chill” is often illustrated by cases such as the Philip Morris dispute concerning cigarette packaging and Vattenfall's proceedings against Germany.
The European Union has not been exempt from the present global legitimacy crisis: in intra-EU relations, the future of the ISDS model has been seriously called into question. A key point in this development was the Court of Justice of the European Union’s Achmea ruling, which held that arbitration clauses of bilateral investment protection agreements between EU Member States are incompatible with EU law. Under the ruling, investors are no longer allowed to submit disputes to international arbitral tribunals; instead, they must pursue their claims before the courts of the Member State concerned.
The ruling created significant practical and theoretical difficulties. On the one hand, the vast majority of international arbitral tribunals – on the grounds of the principle of autonomy of international law – refused to implement the CJEU’s ruling and continued to assert their jurisdiction. On the other hand, critiques in the scholarly literature have warned that the Achmea ruling may lead to a deficit in legal protection and promote forum shopping, arguing that EU law does not always guarantee a level of protection equivalent to that provided by international law. In this context, the establishment of a permanent Multilateral Investment Court, as proposed by the European Union, may offer a solution. Although a significant part of the legal community supports the general idea of the reform, there are still uncertainties regarding its practical implementation and the final form of the proposed court.
Reform or new packaging?
The legitimacy crisis surrounding ISDS does not imply that there will be no need in the future for international legal protection for foreign investors. The real challenge at present is whether traditional ad hoc arbitration can be substituted with an institutionalized system that can provide a permanent solution to the contradictions inherent in the current model. The future of international investment law will depend on whether a delicate balance can be struck between providing investors with predictable legal protection and preserving host States’ regulatory autonomy to pursue public interest objectives.
